Low and volatile oil prices: A reminder to prepare for decommissioning of Nigeria’s aging oil and gas fields
A man at 60 needs a Will; a man at 60, with friends that died intestate really needs a Will. A man at 60, with unstable vitals (health metrics) really should put his ‘affairs in order’! The Nigerian oil and gas industry is over 60 years old, with fields nearing end of life, and this industry exists within a tribe of industries such as in the UK North Sea, the US Gulf of Mexico and other regions that have oil and gas facilities nearing end of life or already reached end of field life. The relationship between Nigeria’s and other oil and gas industries is not distant; the same companies that exist in Nigeria do business in other regions and in that way share from a common knowledge pool that could be drawn from on these matters. The critical vitals for the oil industry constitute oil price, costs, the state of technology, and other aspects of the overall commercial climate including fiscal systems, the state of competition from other energy sources and other oil provinces. These vitals are not looking too good at this time for Nigeria and there is lower than a 50% chance that they improve considerably in the next 20 years; i.e there is a less than 50% chance that prices are much higher and stable in a manner that enhances Nigeria’s oil and gas competitive advantage when put side by side other jurisdictions, or in a manner that favors postponement of these conversation around decommissioning of ageing fields. Nigeria’s oil industry needs a clear and communicable framework for a Will; a plan, an enforceable plan on how its oil and gas facilities and platforms would be decommissioned when oil production ceases from its aging fields or fields that may never get to full robust development due to a gloomy-looking commercial climate.
Asset Retirement Obligations (ARO) and Decommissioning Removal and Restoration (DR&R)
Asset Retirement Obligations (ARO) is the term of reference used by the industry in discussing the obligations to conduct activities leading to the responsible retirement of oil and gas assets after the end of economic field life. A major part of this ARO includes Decommissioning, Removal and Restoration (DR&R) operations. Oil and gas facility DR&R refers to the sets of activities by which, at the end of their useful lives, oil and gas facilities and infrastructures are safely put out of use, removed from location and those locations restored to their natural states or states acceptable to the owners of the land. The actual work of DR&R includes abandonment of all drilled wells, removal of all installations in a safe and environmentally sound manner, and returning those areas to acceptable conditions; these conditions are often, but not always considered to be pristine undisturbed state of the land/area prior to oil development. Many jurisdictions have standards for plugging and abandoning old oil and gas wells. In general, the intention of these standards remain to ensure that untapped oil and gas resources stay in their native zones, don’t flow out and enter other shallower zones or come out to the surface. For some wells that have produced from more than one subsurface zone, there is more than one zone to worry about. This means the barriers to flow must be competent to keep what is left of these resources contained for decades into the future, and to ensure other resources (fisheries, vegetation, and clean air) are not impaired as a result of poorly abandoned oil and gas activities.
Key considerations for Oil and Gas Facility Decommissioning, Removal and Restoration (DR&R)
The most difficult and consequential question in the field of oil and gas asset DR&R is a very simple one; what will it cost to do the job? And often the trite answer: “It depends!” is what the industry has lived with so far. This is because it truly depends on a lot of factors. Some of these factors are as follows:
· What is the standard held by the jurisdiction? What is clean enough for you the regulator?
· What is the scope of DR&R work?
· When is the work going to be done?
· How much could it cost to conduct DR&R?
The challenge in DR&R policy is in how each jurisdiction articulates these requirements and what portions of these are codified in law, and what portions are left to negotiations. And also how each jurisdiction balances the need to be commercially ‘reasonable’, flexible, proactive or responsive.
What is the DR&R standard for the jurisdiction?
Some jurisdictions have taken the position that some installations, such as constructed roads have become useful to communities in the area and for that reason ought to remain. Decisions like this reduce the overall obligation of the company that does the work or DR&R. Other arguments that reduce DR&R cost to the company propose that, if the objective is to do the slightest harm to the environment, the removal of an asset from the location it has occupied for often half a century causes more harm to the ecosystem than leaving that facility in place. In some cases, this argument is pushed one step further, the assets, over a long time, have become even more beneficial to the ecosystem and for that reason ought not be considered liabilities, or removed. Schroeder and Love (2004) discussed several options for managing oil and gas offshore platform DR&R. They proposed that facility removal, for example in the case of a platform, could mean absolute removal, partial removal or toppling the platform. When left in place, they highlight views that argued that this is suitable for aquatic life. They also add that these platforms when removed, could be scrapped, recycled or reused.
What is the scope of DR&R work?
The DR&R standard of the jurisdiction essentially determines the scope of DR&R activities. The scope of work is different for an offshore surface facility than for an onshore surface facility. The scope of work is different for an offshore well head than for an offshore well head. At the level of the well, whether offshore or onshore, subsurface operations are similar: the productive or once productive intervals of the well must be plugged and permanently abandoned. With a rig (whereby the operation is more costly) or without one, the operator has to plug off the productive or open zones of the well using some combination of cement plugs, viscous pills and bridge plugs to contain the well permanently. At the surface, the combination of valves and pipes that make up the wellhead, likely unsightly in inhabited locations, may or may not be required for removal.
Luckily or unluckily, Nigeria’s oil and gas industry has both offshore and onshore areas to worry about.
When is the DR&R work planned to occur?
Generally, the question on when DR&R is planned to occur, is often a more straightforward question. DR&R work is done when it is no longer profitable to go on producing; that is, at the end of economic life of the oil and gas asset. The motif of much of oil and gas exploration reads as follows: the huge oil field justifies development of the resource alongside the construction of the mother facility (facilities). Development then sprawls in a hub and spoke framework whereby smaller fields are now made economic by the existence of a mother facility. Decommissioning happens in an opposite direction. The small fields often run out (economically), or when they persist, make the per unit facility cost of producing the mother field justifiable. But at some point, as oil and gas resources get depleted, per unit facility operations and maintenance cost increases to the point where the entire operation is no longer economic, and abandonment (hopefully, through responsible decommissioning processes) becomes the only option. Just as economies of scale enable development after a discovery is made, economies of scale benefits are often required by operators in order to activate decommissioning operations. Oil and gas companies would typically find it more economic to conduct DR&R operations on more than just one facility at a time.
Finally, there is also a dark side to the argument around the economics of justifying decommissioning. This is borne out of the opportunity cost of decommissioning capital. Even when the economic end of field life is reached for the asset, it is typical that the cost of decommissioning is quite significant, to the point where it becomes more economic to defer decommissioning, where possible. The benefit of deferral could be achieved even at the cost of pursuing marginal bolt-on projects with often questionable economic merit. The perspective of the landowner-mineral interest owner-taxing authority desirous of further resource development may come at odds with that of the surface rights owner – landowner-environmental regulator keen on seeing a decommissioning operation that is not unduly delayed. From the perspective of the later, the imperatives of looming decommissioning cost burden could be seen as leading to suboptimal decision making by the operator, in a manner that does not adequately serve the interest of the regulator. This regulator might see the operator’s economic evaluation as devolving into the performance of projects that, taken in themselves are not economically attractive to perform, but considering the benefits those projects yield, including deferral of decommissioning, are strategically beneficial to the firm. In summary, as decommissioning time looms, it could be more beneficial to do marginal or often much less profitable or borderline projects, if one excludes the benefits those projects yield such as deferred abandonment, where a total divestiture of the asset is not yet feasible.
What could it cost to decommission and abandon Nigeria’s oil and gas fields?
The simple answer is: We don’t know exactly how much. We don’t know how much it will cost because we are not clear about all the several considerations for generating a good estimate. That said, let’s get scientific about the response: we could talk about a cost range or an order of magnitude. What have other jurisdictions experienced? If the UK North Sea or United States are any examples, we know the costs could range in the billions of dollars. Decommissioning in the UK North Sea is estimated at over 100 billion pounds and the Office of Accountability in the US estimates that approximately 3 million orphaned wells in the US would require 435 billion dollars (BCG, 2017; Marketplace.org, 2020). To place these amounts in perspective, granted that Nigeria may not have the number of wells drilled in the US, and that the US estimate may have excluded surface installations and platforms, at 100 billion dollars, the cost of decommissioning 3 million wells in the US exceeds 4 times Nigeria’s national budget for the years 2015 through 2018.
Why is the issue of a more comprehensive and responsive DR&R policy urgent?
Businesses close shop when the cost of doing business exceeds the revenues generated from the venture, and when this situation of loss continuously deteriorates or the entrepreneur runs out of liquidity to stay afloat, and if losses are not reasonably expected to diminish in the future, such that the business returns to profitability. In estimating when DR&R becomes due, companies estimate the point where, hopefully, long after the early years of a producing asset, the operating cost of an oil and gas asset permanently drives the net cash flows into a loss phase. Low oil prices slash the revenue generated from assets and forces the end of economic field life to be sooner, and without a more positive outlook, trigger a sooner DR&R for the asset. The last 5 years have introduced a period of lower prices for crude oil, affecting most of the oil companies who do business in Nigeria. This is part of more global and historic issue. What makes this time different is that capital is drying up for most oil companies and for other companies becoming more expensive. This new realism calls on all oil and gas jurisdictions to take a second look at their decommissioning plans. This process will ensure that plans are comprehensive, clear of obligations and responsibilities and enforceable. For countries with somewhat weaker institutions, this is more crucial.
The need for robust DR&R plans is more crucial for Nigeria for several other reasons. The Nigeria oil industry is generally a higher cost industry than places like the Middle East and the United States. The economics of the Nigerian barrel is saved by production volumes. In an age of OPEC-plus mandated production cuts, against a backdrop of an unrelenting tight oil resurgence in the US, Nigeria’s volume advantage may be fast eroding. Nigeria’s higher costs suggest the criticality of higher prices in keeping Nigeria’s fields profitable and online. Nigeria has experienced a huge wave of asset divestitures in the last decade, often from major international oil and gas companies to smaller independents and local companies. Low oil price periods are associated with more of these divestitures. During asset divestitures, parties stipulate the responsibilities and liabilities accompanying these asset transfers. To the extent that asset transfers may have failed to pay adequate attention to end of asset productive life matters, regulators may be late to this party, or have to re-double efforts to address a host of questions around the nation’s oil and gas decommissioning plans for fields that are at late term.
Decommissioning policy and questions to address: How does Nigeria prepare to responsibly decommission its oil and gas fields?
Oil and gas policy positions that address decommissioning require a good level of care for the regulators and transacting companies alike, as they weed through the myriad questions that emerge.
How would future liabilities be handled? Who will pay for different aspects of decommissioning? What liabilities stay with the departing company and what stays with the acquiring company? Does the jurisdiction encourage joint and several liability; where one and every party up and down the chain of ownership is held liable? How is the cost of DR&R estimated? Are independent third-party estimates encouraged? How financially sound are the parties responsible for decommissioning work? How could their financial health be monitored and managed through time, ensuring that the nation’s tax payers are not left with the duty to decommission oil assets? Do the nation’s Production Sharing Contracts and Joint Venture Contracts address these issues? Does the Petroleum Industry Bill in the medium to late stages of development set a framework within which these concerns could be addressed?
Additionally, other useful questions could include: How do regulators verify that companies are preparing adequately for this day of DR&R? Is it sufficient that companies show Asset Retirement Obligations as line items in their financial statements? Should there be actual contracts and agreements to ensure DR&R work is done when the time comes? Should there be bonding requirements? What happens as companies spin off subsidiaries, merge and acquire others or are merged and acquired by other companies? Do regulators review these corporate activities to ensure the interest of the nation is protected adequately? How do agreements ‘pierce the corporate veil’ and ensure the appropriate corporate entities retain adequate levels of liability? Are parent guaranties allowed; where a parent company stands in for the subsidiary in the event the subsidiary is not available or able to perform DR&R? What happens to cost overruns when DR&R is actually executed? Do jurisdictions allow for capped liabilities or allow full cost of performance to be borne by the companies? Are sinking funds more appropriate than insurance or bonds, for specific companies? Is the DR&R plan a one-size-fits all or on a case by case basis?
On the other hand, the jurisdiction balances this vigilance against other policy objectives. Nigeria will also need to grapple with other questions, and figure out how high the dial is turned to ensure companies are treated fairly, and ensure laws and regulations are not too onerous. In general, most companies want to act right and also protect a corporate image as law-abiding and good environmental stewards. A balanced approach, therefore, to implementing and enforcing decommissioning policy initiatives is crucial, to ensure that the jurisdiction remains attractive for investors in the sector while maintaining their roles as good environmental stewards for the country. Additionally, a comprehensive well thought-out decommissioning policy also ensures that the cost of decommissioning operations are not left on the government to pay, or worse still dictated by imperatives of weaker agreements or environmental standards; this might potentially bind the hands of decision makers to settle for expedient solutions that further fail to protect the nation’s water or agricultural land resources.
Maduabuchi Pascal Umekwe
Umekwe (PhD) could be reached at pascalonline7@gmail.com